Route Planning and Profit EvaluationDr. Peter Belobaba

Network, Fleet and Schedule

Strategic Planning

Module 9 :   11  March 2014

Istanbul Technical University

Air Transportation Management 

M.Sc. Program 

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Lecture Outline

Route Planning and Evaluation Route evaluation issues Route planning models Practical and strategic issues

Route Evaluation Example: Boston-Rome Profit estimates for daily DL non-stop service

Measuring Route Profitability (Baldanza article) Incremental revenues and costs of a flight/route Network contribution and costs Example: Different estimates of route profitability

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Route Planning and Evaluation

The process of route planning and evaluation involves the selection of routes to be flown

Route selection is both strategic and tactical: Essential component of an integrated network strategy or “vision” Route characteristics affect the types of “products” offered to

travelers (e.g., need for business and first class products) Stage length and route characteristics affect airline cost structure,

as longer routes flown with bigger aircraft have lower unit costs Route requirements provide feedback loop to fleet planning Unexpected route opportunities occur with changes to

environment (bankruptcies, competitor withdrawals, new bilateral agreements)

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Route Planning and Profitability

Estimating route profitability requires a detailed evaluation approach: Demand, cost and revenue forecasts required for specific route,

perhaps for multiple years into the future Assumed market share of total demand based on models of

passenger choice of different airline and schedule options Depends to a large extent on presence and expected response of

competitors to route entry

“Route Profitability Models” Computer models designed to perform such route evaluations,

but ability to integrate competitive effects is limited Profit estimates entirely dependent on assumptions used

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Schedule Building

Demand forecast

Traffic allocation

Revenue and Cost Allocation

Example: Airline “Profit Manager”

Source: LAN Airlines (2012)

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Route Evaluation Issues

Economic considerations dominate route evaluation: Forecasts of potential passenger and cargo demand (as well as

expected revenues) for planned route are critical to evaluations Origin-destination market demand is primary source of demand

and revenues for a given route, but far from the only source In large airline hub networks, traffic flow support to the new route

from connecting flights can make it profitable Airline’s market share of total forecast demand for the new route

depends on existence of current and expected future competition The fundamental economic criterion for a planned route is

potential for incremental profitability in the short run, given the opportunity cost of taking aircraft from another route

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Practical and Strategic Issues

Practical considerations can be just as important: Technical capability to serve a new route depends on availability

of aircraft with adequate range and proper capacity Performance and operating cost characteristics of available

aircraft in the airline’s fleet determine economic profitability If the route involves a new destination, additional costs of airport

facilities, staff re-location, and sales offices must be considered Regulations, bilaterals, and limited airport slots can impose

constraints on new route operations, to the point of unprofitability

Strategic considerations can overlook lack of route profit: Longer term competitive and market presence benefits of

entering a new route even if it is expected to be unprofitable in short run

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Route Evaluation Example: Boston-Rome

FLIGHT OPERATING INFORMATION

Total Annual Flights (each direction) 358 (Reflects 98% completion of daily schedule)

Block Hours BOS to ROM 08:00Block Hours ROM to BOS 09:00

Non-stop miles BOS/ROM 4087

• Case Study – Delta Air Lines considers introduction of new daily non-stop flights between Boston and Rome:

• No current year-round non-stop (AZ via Milan)

• Cooperation with AZ as SkyTeam member

• Delta wishes to build up international gateway at Boston

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Estimated DL Operating Costs

Direct Operating Costs

Aircraft Type B767-300Number of Seats 204

Cost per Block-Hour:Crew Cost 1050Fuel/Oil 2400Ownership 970Maintenance 650

Total per Block-Hour 5070

Indirect Operating Costs

Passenger Service 0.015 per RPMTraffic Servicing $26 per EnplanementAircraft Servicing $1,700 per DeparturePromotion and Sales 9.00% of Passenger RevenuesGeneral and Administrative $0.002 per ASM

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Boston-Rome Revenue Estimates

PRORATED DL DEMAND AND FARE ESTIMATES FOR 2006 DEMAND One Way Revenue REVENUE

Total BOS-ROM Local O-D passengers (both directions) 96,000Expected Market Share for one daily flight 70.00%

Local BOS-ROM passengers on new flight 67,200 $440 29,568,000$

Additional Traffic (Estimated for DL at BOS)

Connections US destinations behind Boston to/from ROM 22,400 $380 8,512,000$ Connections to/from BOS beyond ROM 9,600 $330 3,168,000$ Connections behind BOS to/from destinations beyond ROM 3,200 $350 1,120,000$

Total passengers (both directions) 102,400 42,368,000$

Additional Cargo Revenue 11 percent of passenger revenue 4,660,480$

TOTAL 47,028,480$

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Estimated Annual Operating Profit

Aircraft Type B767-300Num ber of Seats 204ASM 596,963,568Seat Departures 146064Passengers Enplaned 102400Average Load Factor 70.11%

DIRECT OP COSTS 30,856,020$ PAX SERVICE 6,277,632$ TRAFFIC SERVICE 2,662,400$ A IRCRAFT SERVICE 1,217,200$ PROM OTION/SALES 3,813,120$ GEN ADM INISTRN 1,193,927$

OPERATING COSTS 46,020,299$

OPERATING PROFIT 1,008,181$

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Measuring Route “Profitability”

Airline costs are driven by fleet and flight schedule Fleet drives fixed costs (capital costs) and variable cost rates

(fuel burn rates, maintenance rates) Flight schedule drives utilization and thus variable costs Costs are incurred on a flight basis and on a network basis

Airline revenues are driven by O-D markets Prices are set by competitive considerations or by regulation Revenues are earned on a passenger itinerary basis

Scheduling decisions are often made at the route and flight departure level Airline managers must decide which flight legs to remove so that

other flight legs can be added

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Approaches to Flight Profit Measurement

Ideally, add/change/remove a flight leg and then measure the profitability given that the rest of the network can be re-optimized Captures interactive or network effects of both costs and

revenues Not easy as it requires a good model of the entire operation

Another approach – allocate all costs and revenues on a flight leg basis and then treat each leg as being independent of the rest of the network Allocation schemes are always subjective Does not capture network effects, very important in most cases But, much easier to conceptualize

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Sample Network (Baldanza Article)

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Flight-Level Profitability

Incremental Revenues

Incremental Costs

Measures of Profitability

Network Contributions and Costs

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Incremental Revenues (SYR-OMA)

Two sources of incremental passenger revenues Passengers boarding in SYR and deplaning in OMA

(Local Revenue) Passengers boarding in SYR and connecting in OMA to LAX or

SFO (Connecting Revenue)

Connecting O-D revenues allocated to each flight leg Proration methodology needed to split O&D fare into component

parts (e.g. mileage, ratio of full fares) Or, assign total connecting O-D fare to flight leg being analyzed

Implicit assumption is that all revenues from a flight segment will be lost if the segment is cancelled Reality is that airline might recapture some of this revenue

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Incremental Costs (SYR-OMA)

Variable Operating Costs

Aircraft Ownership Costs Equivalent leasing costs based on duration of flight segment

Overhead and Non-Operating Costs Equivalent share of other fixed costs based on duration of flight

segment

Fully allocated flight costs equals the variable operating costs plus the aircraft ownership costs plus the allocated overhead and non-operating costs.

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Network Contributions and Costs

Contributions to Rest of Network Additional revenue on other segments due to presence of SYR-

OMA segment

Costs to Rest of Network Cost of processing SYR connecting passengers at OMA Incremental cost of having more passengers on the connecting

segments out of OMA Opportunity Costs of selling seats beyond OMA, which could

have been occupied by passengers from other O-D markets (known as “network displacement costs”)

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Revenues & Costs for Sample Network

Local SYR-OMA O-D revenue: $6,000

Connex prorated to SYR-OMA: $1,500

Connex proration to other legs: $4,000

Variable operating costs: $4,500

Aircraft ownership costs: $2,000

Allocated overhead & non-operating costs: $1,500

Network variable costs: $ 700

Network opportunity costs: $ 500

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SYR-OMA Profitability for Sample Network

Variable Leg Profitability with Network Contribution: $6,300

Variable Leg Profitability with Network Contribution andOpportunity Costs: $5,800

Variable Leg Profitability with Aircraft Ownership and Network Contribution: $4,300

Variable Leg Profitability with Network Contribution, Aircraft Ownershipand Opportunity Costs: $3,800

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SYR-OMA Profitability for Sample Network

Fully Allocated Profitability with Network Contribution: $2,800

Fully Allocated Profitability with Network Contribution andOpportunity Costs: $2,300

Variable Leg Profitability: $3,000

Variable Leg Profitability withAircraft Ownership: $1,000

Fully Allocated Leg Profitability: ($ 500)

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What is the right profitability measure?